In a stunning turn of events, Wall Street recently witnessed an unexpected cross-asset rally, underscoring the pitfalls of market timing. The shift in sentiment, partly fueled by Federal Reserve Chair Jerome Powell’s less hawkish stance, marked the most significant collective surge in financial markets since November 2022. Key factors contributing to this rally included a manageable Treasury borrowing plan and a weaker-than-expected jobs report, which catered to dovish investor appetites.
This rally can be partly attributed to bearish price action in recent months and defensive positioning. Hedge funds and systematic quants, who had been caught on the wrong side of the market, were compelled to reinvest in various assets throughout the week.
Luke Hickmore, an investment director at Abrdn Investment Management, noted, “The consensus had moved to a soft landing, rate-pause Goldilocks. There are signs of short-covering everywhere.”
However, it may be unwise to assume that recent events signal anything more than a relief rally, given the lack of long-term conviction in stocks and bonds, and the uncertain corporate profit trajectory.
The S&P 500 and the Nasdaq 100 both experienced their most substantial weekly gains of the year, with each surging by approximately 6%. Simultaneously, the 10-year Treasury yields plummeted by over 25 basis points, marking the most extensive weekly drop since March. As stocks soared, the world’s largest Treasury exchange-traded fund registered a 4% increase, while investment-grade and junk bonds also advanced in unison, constituting the most substantial upward move in 17 months, as per Bloomberg data. (Commodities were the exception to this trend.)
The prevailing gloom was evidenced by a three-month selling spree by hedge funds, the second-largest of the past decade according to data from Goldman Sachs Group Inc.’s prime brokerage. Moreover, net short bets on Treasuries held by professional speculators were hovering near record levels before the latest bond rally, according to Commodity Futures Trading Commission data.
Both bearish and bullish views faced challenges during this rally. Investors who bet on stock declines suffered losses, with a basket of most-shorted companies gaining 13% in value. On the other hand, Cathie Wood’s flagship ARK Innovation ETF (ARKK) achieved its best week on record, surging nearly 19%, benefiting rate-sensitive speculative tech stocks as traders reduced rate-hike expectations.
Commodity-trading advisers, such as fast-money quants, currently maintain a record $302 billion short bet in bonds, as reported by Scott Rubner, a managing director with two decades of experience in studying fund flows. Rubner anticipates that this short-cover rally is still in its early stages, with potential bond purchases of around $105 billion if prices remain stable and possibly as much as $456 billion if the rally persists. The short positioning of CTAs in stocks could also lead to an $81 billion buying spree in S&P 500 futures if the positive momentum continues.
Among the catalysts for this week’s market movements, two were particularly notable. The US Treasury announced plans to slow the growth rate of quarterly debt sales, temporarily alleviating concerns about an ongoing downturn in Treasuries. Additionally, a weaker-than-expected employment report on Friday suggested that the labor market may be responding to the Fed’s efforts to cool it.
In the midst of these events, Powell’s remarks were interpreted as dovish by investors, despite his repeated assurances that decisions about future rate cuts are contingent on incoming data. Traders paid close attention to Powell’s observation that rising long-term bond rates might help curb inflation by restraining economic activity. His comments also suggested that hawkish forecasts made by central bankers in September are losing relevance, as he mentioned, “the efficacy of the dot plot probably decays,” and that the rate-hike cycle has “come very far.”
Priya Misra, a portfolio manager at JPMorgan Asset Management, commented, “The Treasury and Fed responded to the market, and now the market is responding to Treasury and Fed. Data this week supports the Fed’s patient stance. Risk assets will get nervous if a recession looks imminent, but that’s not today’s story.”
According to Fed swaps, traders currently see only a 16% chance of another rate hike by January, with a rate cut fully priced in by June instead of July.
Emmanuel Cau, head of European equity strategy at Barclays Plc, remains cautious about the macroeconomic environment, noting, “The bar is low for a bounce on rates relief and peak duration pain. The transmission mechanism from tighter monetary policy works with a lag, and central banks are unlikely to reverse course unless something breaks.”
